The Community Reinvestment Act (CRA) is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low- and moderate-income (LMI) borrowers and neighborhoods, consistent with safe and sound banking operations. The CRA was enacted by Congress in 1977 (12 U.S.C. 2901) and is implemented by Regulations 12 CFR parts 25, 228, 345, and 563e. The Regulation was revised in May 1995.
The CRA requires that each insured depository institution's record of helping to meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution's application for deposit facilities (i.e., new branches), including mergers and acquisitions. CRA examinations are conducted by the federal agencies that are responsible for supervising depository institutions: the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS). These agencies comprise the Federal Financial Institutions Examination Council or FFIEC.
The four federal agencies approved examination procedures to implement the revised Community Reinvestment Act (CRA) regulations that were published in the Federal Register on May 4, 1995. There are four sets of procedures—procedures for small institutions, for large retail institutions, for wholesale and limited purpose institutions, and for institutions that have been approved for evaluation under a strategic plan. Recently, the agencies created a new category—Intermediate Small—for institutions between $250 mm and $1 Bil in assets. The four different procedures correspond to the four alternative evaluation methods provided in the revised CRA regulations and are designed to respond to basic differences in institutions' structures and operations.
In summary, the CRA regulations measure how successfully an institution meets the community development and credit needs of its assessment area (geographic operating “footprint”) through lending, investments, and service. For large retail institutions, the test weightings are 50%, 25%, and 25%, respectively. Effective Sep. 1, 2005 intermediate small banks will be measured on lending and a flexible community development test; whereby the bank can establish its own mix of community development lending, investment, and service.
The federal agencies have provided answers to numerous inquiries from financial institutions, investment managers, and other parties interested in community development, pertaining to the provisions and topics of the CRA regulations. The OCC, on behalf of the other FFIEC members, published a series of Interpretive Letters soon after the release of the revised regulations in 1995. An official Interagency Q&A Regarding Community Reinvestments notice was published in the Federal Register on Jul. 12, 2001 and the number of Interpretive Letters on the CRA has since slowed dramatically.
The CRA regulations define community development, qualified investments and other terms to guide regulated institutions in their compliance. Some of the key definitions in the regulations include:
“Qualified Investment” means a lawful investment, deposit, membership share, or grant that has as its primary purpose community development.
“Community development” means: (1) affordable housing (including multifamily rental housing) for low- or moderate-income individuals (LMI); (2) community services targeted to low- or moderate-income individuals; (3) activities that promote economic development by financing businesses or farms that meet the size eligibility standards of the Small Business Administration's Development Company or Small Business Investment Company programs (13 CFR 121.301) or have gross annual revenues of $1 million or less; or (4) activities that revitalize or stabilize low- or moderate-income geographies.
“Community development loan” means a loan that: (1) has as its primary purpose community development; and (2) except in the case of a wholesale or limited purpose bank: (i) has not been reported or collected by the bank or an affiliate for consideration in the bank's assessment as a home mortgage, small business, small farm, or consumer loan, unless it is a multifamily dwelling loan and (ii) benefits the bank's assessment area(s) or a broader statewide or regional area that includes the bank's assessment area(s).
“Income level” includes: “Low-income”, which means an individual income that is less than 50 percent of the area median income, or a median family income that is less than 50 percent, in the case of geography; “Moderate-income”, which means an individual income that is at least 50 percent and less than 80 percent of the area median income, or a median family income that is at least 50 and less than 80 percent, in the case of a geography. (Thus low-to-moderate income (LMI) includes individuals whose income is less than 80 percent of area median income, or median family income that is less than 80 percent, in the case of a geography.)
“Area Median Income” means the median family income for the MSA (Metropolitan Statistical Area), if a person or geography is located in an MSA; or the statewide non-metropolitan median family income, if a person or geography is located outside of an MSA.
“Affiliate” means any company that controls, is controlled by, or is under common control with another company. The term “control” has the meaning given to that term in 12 U.S.C. 1841(a)(2), and a company is under common control with another company if both companies are directly or indirectly controlled by the same company.
The Interagency Q&A and Interpretive Letters make it clear that qualified investments may be held directly or indirectly (i.e., via a mutual fund) and still receive favorable CRA consideration. Similarly, qualified loans may be originated or purchased, singularly or in a loan consortium. The Q&A and OCC Interpretive Letters specifically confirm that mortgage-backed securities (MBS) backed by loans made to low-to-moderate income borrowers are qualified CRA investments because they promote affordable housing for LMI individuals. As an approved CRA investment, Fannie Mae, Freddie Mac and several large banks make a market in taxable CRA-targeted MBS and collateralized mortgage obligations (CMOs), selling them to banks, funds, and other investors.
Bank owned life insurance (BOLI) is life insurance owned by banks (or grantor trusts) on the lives of executives and directors. BOLI is regulated by the OCC (and OTS, FRB, and FDIC) through a series of Banking Circulars (249) and Bulletins (96-51, 2000-23 and 2004-56) which provide guidance to ensure that bank purchases of life insurance are consistent with safe and sound banking practices. Banks typically purchase BOLI to cover the loss of key employees and to help manage human resource liabilities such as nonqualified pensions and post-retirement welfare benefits.
As life insurance, and under present tax law, BOLI enjoys tax-deferred cash value growth and tax-free death benefit proceeds. Further, the generally accepted accounting principles (GAAP) treatment for life insurance requires that the cash value be carried on the balance sheet and thus the growth in cash value is recognized in current earnings. The current cash surrender value (CSV) is reported in Other Assets and the periodic increase in CSV is reflected in book income.
The insurance industry offers several types of policies to address customer preferences regarding liquidity (Modified Endowment Contract (MEC) vs. Non-MEC), volatility (Guaranteed return vs. Mark-to-market), and credit risk (General Account vs. Separate Account). Larger institutions have historically preferred the improved credit risk and investment flexibility inherent in Separate Account policy designs. Most large BOLI purchases have been single premium MEC policies that will be held until the death of the insured employee; implying a 40+ year holding period. Presently, the ten largest U.S. banks which hold BOLI collectively have over $40 Billion of cash value recorded on their balance sheets. Most of it is in Separate Account BOLI.
Separate account life insurance permits the policy owner, within limits, to direct how the cash value is invested. The portfolio management of the account is provided either by the insurance company or a third-party investment advisor (sub-advisor). It is also common to have a Separate Account “plug-in” an insurance dedicated fund (IDF) that is offered and managed by independent asset managers. Portfolio managers can replicate existing mutual fund strategies but cannot comingle insurance and non-insurance dollars. Thus IDF “clones” of popular funds are often built and offered to insurance company Separate Accounts to attract new assets to manage.
Separate Accounts are legal/accounting entities that are owned by the sponsoring insurance company for use with variable life insurance and annuities. Assets in the Separate Account support liabilities associated with policy contracts and policyholders respective asset allocations. Properly structured, Separate Accounts assets are insulated from any liabilities arising from the General Account of the insurance company. Separate Accounts have been afforded “look-through” treatment by regulators; both for determining “bank-eligibility” and risk-based capital (RBC) treatment.
The OCC and other banking regulators define those permissible bank-eligible investments may be held by a bank within life insurance. Generally such investments are limited to government guaranteed or highly rated fixed-income securities. Thus, most Separate Account BOLI is invested in portfolios of U.S. Treasury and Agency securities; MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae; and other high-grade fixed income securities.
In October 2004, the OCC publicly released Interpretive Letter #1008 which specifically addressed an inquiry from a division of a bank regarding the feasibility of obtaining CRA investment test credit within an appropriately designed (that is, one which exclusively holds CRA qualified investments) separate account BOLI policy. The OCC concluded that “an investment held in a BOLI-CRA separate account would be a qualified investment for the purpose of the bank's CRA performance, provided that the investment has a primary purpose of community development and benefits the bank's assessment area” on the primary basis that, per interagency guidance, CRA investments can be made directly or indirectly.
As explained more fully below, the present invention provides a mechanism whereby a bank can enjoy the tax benefits and other advantages of Separate Account BOLI (asset insulation, RBC look-through, etc.) while, at the same time, assisting the bank in meeting its requirements under the CRA.